Henderson flags suitability issues with passive funds

Henderson flags suitability issues with passive funds

Active manager Henderson has flagged that pressure for lower fees in the fund industry could pose a problem when it comes to the suitability of passive funds.

The fund house pointed to the mounting pressure to cut fund charges, meaning providers increasingly need to sell lots of their products to make their business models viable.

This, Henderson warned, could put an increased focus on quantity instead of quality.

Julien Cuisinier, head of investment analytics at Henderson Global Investors, raised potential suitability issues when it comes to the promotion of passive products, which are cheaper than active funds  - for example, that a growing focus on price could ignore portfolio construction and stock selection.

Mr Cuisinier said passive products which track an index need a minimum price to optimise the tracking, but warned some exchange-traded funds are finding it hard to compete because fees are being pushed so low.

“Those cheap ETFs don’t have the resources to add complexity to the way they screen stocks and create the portfolio," he said.

“If an adviser wants to add some more exotic kind of product to a client’s portfolio then it can become very hard to know what they are investing in.”

The analytics boss also pointed out that because passive funds simply track the market, decisions around diversification are pushed onto the adviser or end investor, meaning the provider can then “hide behind the market”.

Nick Blake, the European head of product and marketing at Vanguard, one of the largest passive players in the UK, said his firm is not under pressure to chase cyclical trends or ‘hot’ products when it comes to Vanguard’s own product line. 

He also pointed out economies of scale in the passive sector can benefit investors because this allows providers to return profits to investors in the form of lower expenses. 

“That said, we are concerned about the scale and pace of product proliferation in the industry, particularly in the more esoteric areas of the market.” 

He argued there was also a race by providers to differentiate product offerings, as they look to get more market share by widening their product lines.

When it comes to ensuring products are suitable for clients, Mr Blake said advisers are an “important safeguard” for investors.

“In our experience, many advisers have realised that low cost index funds are a great place to start, as they can fulfil the asset needs of many investors.

“For those with greater appetite for risk, active management offers potentially enhanced returns, typically at a higher cost.”

Dan Attwood, retail proposition manager at Legal & General Investment Management, which runs both active and passive funds, said scale is important in the management of index funds because it has an impact on costs and efficiency.

In this regard, he argued quantity actually improves the quality of an index fund.